Top Five Issues for the LNG Industry in 2017

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As low oil prices dragged on for another year,  LNG sellers and developers continued to face hurdles in 2016. Unfortunately but not surprisingly, we witnessed more projects cancelled or put on hold, including LNG Canada and Oregon LNG.[1] Despite the difficult climate, a handful of projects were able to move forward last year.[2]

As 2017 begins, there are signs for optimism: some are predicting that we may begin to see a rebound in oil prices over the next two years. Does a rebound in oil prices also mean a recovery in the LNG industry? Will new markets continue to open up, unlocking more LNG and natural gas demand? Will new technology deliver more cost-effective solutions for floating and smaller-scale LNG?  The answer will likely depend on other factors at play in LNG. In this article, we examine top five potential issues that may affect the LNG industry this upcoming year.

Requirements for Greenfield Projects to Achieve a Positive Final Investment Decision (“FID”)

Along with the potential rebound in oil prices, there is another prediction that suggests 2017 may provide a more favorable environment for greenfield LNG export projects under development. Some commentators have forecast that the current LNG oversupply will be eliminated by as early as 2021.[3] Given the typical four-year construction cycle for LNG export projects, this means 2017 may provide an opportunity for greenfield LNG projects to regain momentum in progressing towards FID. To do so, project developers who have faced strong headwinds the past couple of years must overcome at least a few more hurdles.

One, project developers must procure sufficient development capital to reach FID. Development of greenfield LNG export projects is an expensive venture, requiring significant funding for permitting, design and engineering and marketing. A few projects have managed to procure significant development capital in 2016.[4]  Will others be to attract the necessary development funding to continue their efforts in progressing their projects?  

Second, projects will need to procure long-term offtake contracts. This will require a commitment and change in strategy from at least some of the large LNG buyers who have publicly announced severe cutbacks on long-term contracts.[5] While European buyers have long sought to break away from Russia, none have (yet) signed long-term offtake with any greenfield projects since those for Cheniere’s Corpus Christi LNG project and Russian exports to Europe increased in 2016.[6] Will other project developers be able to convince buyers to contract for the long-term offtake necessary to support their projects? Will new buyers, particularly those in less established gas import markets, take on a larger role and bridge some of that long-term contract gap? 

Last, if projects are unable to secure the traditional “bankable” long-term offtake contracts to support project financing, projects may need to find alternative means for securing project financing. While this has yet to be accomplished, as discussed further in issue 5 below, even Japan’s Ministry of Economy Trade and Industry (“METI”) is encouraging financial institutions to find innovative financing solutions for LNG export projects. Given there are signs that some companies are already taking action in furtherance of METI’s suggestions,[7] could such innovation on financing be made this year?

Blurring of Roles Among LNG Participants

Finding long-term buyers to support greenfield LNG projects may have become more challenging given the increasingly blurred lines among the roles played by various LNG participants. Traditionally, the LNG industry has been dominated by a small club of players – on one side, large oil and gas producers that export LNG and on the other side, utilities that import LNG for domestic use. In the past two years, we have seen the lines between traditional LNG players blur. 

Today, many traditional LNG buyers are joining commodity trading entities in entering the LNG spot trading arena.[8] And, as further discussed below, both traditional LNG exporters and importers alike are seeking to develop new LNG downstream markets. These efforts to branch out are spurred in part by liberalization of domestic energy markets underway in many countries, including Japan, South Korea and China. As detailed in a recent King & Spalding article,[9] there have been a number of significant market reform initiatives across Asia, including the introduction of open / third party access regulations. 

It will likely not be known for a few years which companies will prove successful in these new pursuits. For 2017, however, the question remains how will project developers fare in the face of such new competition and in navigating through a more complex market to identify creditworthy offtakers who are willing to commit to long-term supplies?

Development of Downstream Markets

With low oil prices and an oversupply of LNG, players from Shell to Total to Tokyo Gas are actively pursuing the development of downstream LNG markets.[10] Of particular interest to developers are floating-storage-and-regasification units (“FSRUs”) and LNG-to-power projects. Of the five countries that began importing LNG in 2016, three involve FSRUs, two of which are in connection with LNG-to-power projects.[11]  And many more are in the works.[12]

It remains to be seen how many of these downstream projects will ultimately be constructed and whether they may provide the level of demand that LNG exporters and sellers are seeking to achieve. One challenge for these downstream projects (in particular, the LNG-to power projects) is complexity. Integrated LNG-to-power projects involve many pieces of the LNG value chain, from LNG procurement to alignment of delivery between the LNG terminal and the power plant, including interconnecting pipeline infrastructure, to inventory management. Accordingly, these integrated projects often involve multiple domestic and offshore venturers. The revenue stream from the power purchase agreement (or equivalent) is critical to the long-term viability of an integrated project as that revenue stream will need to cover (for example) LNG procurement costs, FSRU charter / hire costs, plant and infrastructure construction and operating costs. The real challenge remains securing limited recourse financing, which in turn hinges on achieving alignment across all the pieces of the project and on the creditworthiness of all those involved. 

Whilst these projects potentially provide a means of stimulating LNG demand, it is important to note that these projects tend to have lower or less reliable gas usage requirements depending on the duration of the power purchase agreement (or equivalent) and the manner in which the power generation facility is dispatched. For other gas import projects which are not connected to specific power generation facilities, there may be less incentive to commit to long-term contracts.[13]

The increase in FSRUs and LNG-to-power projects certainly will provide opportunities for the spot and medium-term market. That is not to say these projects will not seek long-term supplies; Pakistan recently issued an LNG supply tender with a 15 year term.[14] Will greenfield LNG export projects be able to procure the 15 to 20 year commitments required for its financing from these FSRU and LNG-to-power projects?  

Increase in LNG Disputes

As further detailed in a recent article by LNG guru Philip Weems[15], disputes tend to arise in times for rapid market changes. Until the LNG market rebalances, will more disputes be initiated?  One thing is certain, buyers may be encouraged by the recent successful price renegotiations between Petronet and Qatar, Engie and Statoil and Engie and Gazprom.[16] And certain contract renegotiations remain under way, including that between Gail and Gazprom.[17] Will the parties to existing renegotiations reach an amicable solution or will disputes arise because no amicable solution is agreed?

Impact of Governmental Actions

Governmental support is always important to the success of an LNG project, and governments are careful to balance the desire to incentivize development with the goal of realizing benefits from the development. Contrast the recent experience of British Columbia against that of Australia. On the one hand, the British Columbian government has been criticized for moving too slowly and thereby resulting in the province missing out on the recent boom in North American LNG exports.[18] On the other hand, as Australia is gearing up to become the largest LNG exporting country, but the government is reviewing its profit-based tax, which has yielded much lower revenues than expected.[19] How will these two recent examples influence governments going forward with respect to the LNG projects currently under development?

Another recent development is a government extending its activities beyond fiscal stability and regulatory approvals for LNG projects. Year 2016 saw governments taking a front-and-center role in the LNG markets and/or trying to influence the direction of LNG markets. These include the State of Alaska’s bold move to take over as the lead developer of the Alaska LNG project; this move is aimed at taking advantage of tax exemption benefits and thereby making the project more cost competitive.[20] Traditionally, governments take equity stakes but the private sector takes the lead in project development. Will we see other governments make innovative maneuvers to aid in the development or financing of a project?

In addition, it is important to note the Japanese government’s efforts to steer commercial changes and practices in the LNG industry through METI’s 2016 publication “Strategy for LNG Market Development.”[21] Those in the LNG industry understand the influence METI has, especially among the LNG buyers of the world’s largest LNG importing country. In fact, certain of METI’s recommended actions for fulfilling these strategies are already underway, including the Japanese government’s current review of destination restriction clauses in existing LNG contracts,[22] Japanese buyers’ push against such clauses in new contracts,[23] and Japanese companies’ venturing into new LNG markets abroad.[24]

While this publication is arguably aimed at lowering LNG costs for Japan, certain of these actions may also benefit LNG export projects – in particular, METI urges “financial institutions to positively review their financing policy in response to current and future circumstantial changes surrounding LNG” and pointed out that LNG buyers are cutting back the share of long-term contracts in their supply portfolios.[25] Will 2017 see additional developments corresponding to METI’s suggested actions?

Conclusion

Within the past two years, we have seen a marked shift in the LNG landscape, from the emergence of new buyers and new markets, advances in medium and small-scale technology, certain buyers’ reluctance to commit to long-term contracts in an oversupplied market and traditional players investing in other parts of the LNG value chain. There are signs that 2017 will be an exciting year for the industry. We look forward to seeing how the above issues play out in 2017 and affect the potential recovery in LNG.

[1] Karen Thomas, Shell-Led LNG Canada Delays Final Investment Decision, LNG World Shipping, Jul. 12, 2016, and Richard Nemec, Oregon LNG Columbia River Project Scrapped, Daily GPI, Apr. 18, 2016. 
[2] These include Indonesia’s Tangguh LNG train 3 expansion project, U.S. Elba Island project and Canada’s Woodfiber project (conditional FID pending governmental approval). See Robert Brelsford, Tangguh LNG Partners Let Contract for Third Train, Oil & Gas Journal, Sep. 14, 2016;  FID Reached on Woodfibre LNG Project in Canada, LNG World News, Nov. 7, 2016; and Liz Hampton, Kinder Morgan to Begin Construction on Elba Liquefaction Project November 1, Reuters, Oct. 19, 2016.
[3] Jesse Snyder, LNG Markets Could Return to Balance by 2021 and Spur “Second Wave” of Opportunity, Financial Post, Oct. 4, 2016.
[4] On August 22, 2016, Venture Global announced its latest round of capital raise and noting that it has raise over $280MM to date for its two proposed LNG projects on the U.S. gulf coast. See press release at http://venturegloballng.com. On Dec. 20, 2016, Total announced it is investing $207MM in Tellurian, which is developing the Driftwood LNG project on the U.S. gulf coast. See press release at http://www.total.com.
[5] Japanese buyers Jera and Osaka have both announced plans to cut back significantly on long-term contracts. See Osamu Tsukimori, Japan's Jera Plans 42 Percent Cut in Long-Term LNG Contracts by 2030, Reuters Aug. 11, 2016; and Osamu Tsukimori, Japan's Osaka Gas May Not Sign Long-Term LNG Contracts for Years, CNBC, Sep. 12, 2016.
[6] In fact, Gazprom’s recent ability to retain European demand by using new auction mechanism and renegotiating long-term prices begs the question whether European buyers are simply looking for lower-priced gas supplies. See Into Landauro, Gazprom Agrees to Link Price of Gas Sold to Engie to Gas Market, Not Oil Market, The Wall Street Journal, Apr. 12, 2016; Stuart Elliott, Long-Term Natural Gas Contracts, New Trade Mechanisms to Boost Gazprom Market Position, Platts, Nov. 23, 2016; and Oleg Vukmanovic, Europe Misses out on Global LNG Surge as Russian Gas Pumps at Record Rate, Reuters, Jan. 9, 2017.
[7] See discussions in issue 5 below.
[8] Even Origins Energy (a traditional an upstream producer and LNG exporter) has entered the LNG trading business.  See Angela Macdonald-Smith, Origin Energy Signs Deal to Sell LNG to China's ENN Energy, The Sydney Morning Herald, Mar. 1, 2016.
[9] Richard Nelson, Gas Market Reform: The Advent of Third Party Access in Asia? November 2016
[10] See Ron Bousso and Oleg Vukmanovic, Coming Wave of Gas Puts Focus on Finding New Shores, Reuters, Jun. 13, 2016; and Tokyo Gas to Form LNG Joint Venture in Vietnam, Thanh Nien News, Jul. 9. 2016.
[11] The five countries are Poland, Jamaica, Indonesia, Barbados and Finland, and the LNG-to-power projects are those in Jamaica and Indonesia. See Karen Thomas, Supply Glut Opens New LNG Markets, LNG World Shipping, Oct. 6, 2016. 
[12] Id. 
[13] For example, Pakistan has a 15-year FSRU charter and recently issued LNG supply tenders. Approximately half of the annual volumes it sought is pursuant to the five year supply tender. See Pakistan LNG Issues Tenders Seeking 240 Cargoes, LNG World News, Nov. 2, 2016.
[14] Lowest Bids in Pakistani Tender Reported to be from Big Traders, Poten & Partners’ LNG in World Markets, Dec. 2016.
[15] Philip Weems, A Look Inside The Recent Rise In LNG Disputes, Law360, Aug. 4, 2016.
[16] Engie, Statoil to Renegotiate Long-Term Gas Supply Agreements, LNG World News, Dec. 2, 2016; Dan Murtaugh, LNG Buyers Dreading 2040 Try to Renegotiate Amid Supply Glut, Bloomberg, May 5, 2016; and ENGIE and Gazprom Export Agree on the Price Revision of Their Long-Term Gas Contracts, Apr. 12, 2016, press release available at http://www.engie.com.
[17] Nidhi Verma, Oleg Vukmanovic and Dmitry Zhdannikov, India's GAIL, Russia's Gazprom Renegotiating LNG Deal, Reuters, Jul. 24, 2016.
[18] Geoffrey Morgan, LNG Projects Progressing in Nova Scotia, While B.C. Faces Delays, The Financial Post, Feb. 10, 2016; and Japan Warns B.C. Risks 'Missing the Chance' to Export LNG to Asia as Review Drags on, Vancouver Sun, Mar. 22, 2016.
[19] Australia to Review Oil and Gas Taxes, LNG World News, Nov. 30, 2016.
[20] Alex DeMarban, Governor Feuds with ExxonMobil as State Moves to Take over LNG Project, Alaska Dispatch News, Dec. 4, 2016.
[21] Available at http://www.meti.go.jp/english/press/2016/pdf/0502_01b.pdf.
[22] Stephen Stapczynski and Emi Urabe, Japan to Seek LNG Contract Details Amid Resale Probe, Bloomberg, Nov. 16, 2016.
[23] Tsuyoshi Inajima and Emi Urabe, Another Buyer in World’s No. 1 LNG User Resists Resale Curbs, Bloomberg, Sep. 12, 2016.
[24] See e.g., Tokyo Gas to Set up LNG Joint Venture in Vietnam, Nikkei Asian Review, Jul. 9, 2016.
[25] Id. at page 10.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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